intelligent cloning - the value firm
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Copyright © 2021 by The Value Firm®. All rights reserved.
Intelligent Cloning The Spring 2021 Edition
All of those risk models… They are great, until complete
chaos happens. And then all the correlations break down
and can suck you into a false security.
In this Edition on Intelligent Cloning we’ll start with some
thoughts on the quote above. Then we’ll have a look at
the idea of Hyper Value Creators, by looking at the
Terry Smith Funds and the AAII Buffett Hagstrom
Screener, and finally some comments on a study entitled
“The Makings of a Multi-Bagger” by Alta Fox Capital
Management. Enjoy!
The quote above is from Stanley Druckenmiller,
Chairman and CEO of Duquesne Family Office. To put
this quote into perspective, let’s have a look at this
graph from Dr. Jean-Paul Rodrigue, Professor of Global
Studies and Geography, Hofstra University in
Hempstead, New York.
Mathematical models work until they don’t. During the
stealth phase, the awareness phase and way into the
mania phase you can build up a false sense of security by
using these models. And then the bubble bursts anyhow.
No warning signs.
For quite some time now, Howard Marks emphasizes
cautiousness. “One of the smartest things I have learnt
was back in the early 70s and wise investors said to me
that there are three stages to the bull market, the first
stage when only a very few foresighted people began to
believe there could be improvement. The second stage
when everybody knows things are getting better. And
the third stage when people believe things can only get
better forever. It is important to know which stage we
are. We are certainly not in the first stage, we are
probably not in the second stage. We have to worry
about being in the third stage and that is why I think it is
important to be cautious.”
“The biggest risk of all is the possibility of rising interest
rates. Rates have declined quite steadily for the last 40
years. This has been a huge tailwind for investors, since a
declining-rate environment lowers the demanded
returns on assets, making for higher asset prices. The
linkage between falling interest rates and rising asset
valuations is a good part of the reason why p/e ratios on
stocks are above average and bond yields are the lowest
we’ve ever seen. But the downtrend in rates is over.
Thus, while interest rates can rise from here – implying
higher demanded returns on everything and thus lower
asset prices – they can’t decline. This creates a
negatively asymmetrical proposition. So today’s high
asset prices may be justified at today’s interest rates, but
that’s clearly a source of vulnerability if rates were to
rise.”
Also Charlie Munger recently said that the U.S. Stock
Market is overvalued, but he doesn’t know when the
bubble will burst. The inconvenient question to be
answered is how much cash you want to keep aside to
be able to invest when the bubble bursts, knowing that
you don’t know when it will burst.
Terry Smith
Terry Smith, founder and chief executive of Fundsmith,
looks for companies with above average ROCE, gross
margin, operating margin, cash conversion ratio and
interest cover ratio. That is certainly a solid approach
and the results speak for themselves: an annual
compounded annual growth rate (CAGR) for the
portfolio of 18.2% since November 2010. His way of
working?
Buy good companies. Don’t overpay.
Do nothing.
Copyright © 2021 by The Value Firm®. All rights reserved.
Here are the Terry Smith 10 Golden Rules:
1. If you don’t fully understand it, don’t invest
2. Don’t try to time the market
3. Minimize fees
4. Deal as infrequently as possible
5. Don’t over diversify
6. Never invest just to avoid tax
7. Never invest in poor quality companies
8. Buy shares in a business which can be run by an idiot
9. Don’t engage in “greater fool theory”
10. If you don’t like what’s happening to your shares,
switch off the screen
The 10 year CAGR of 18.2% is exceptional. He would do
even better than that if he decided to just focus on
Hyper Value Creators (HVCs).
So what is a HVC? Well, the Oracle of Omaha Warren
Buffett once said that a good company is a company that
earns a high rate of return on tangible assets. And the
best ones are the ones that earn a high rate of return on
tangible assets and grow.
What I am looking for is the very best of the best, the
Hyper Value Creators (HVCs), and these are companies
with an exceptional high Value Creation Engine (VCE),
which is indeed a for growth adjusted Return on
Invested Capital (ROIC) measure. In the Terry Smith
portfolio there are quite some Hyper Value Creators:
Company TSR (%)
Microsoft Corp. 787
IDEXX Laboratories 1318
Facebook Inc. 583
Intuit Inc. 683
Philip Morris Intl. 37
Visa Inc. 103
Starbucks Corp. 542
Qualys Inc. 603
Fortinet Inc. 746
Verisign Inc. 452
Paycom Software Inc. 2469
Mercadolibre Inc. 2647
Zoetis Inc. 413
PayPal 665
MSCI Inc. 1063
The TSR (%) is the 10 year Total Stock Return as per 23
February 2021. On average, that is a 10 year gross CAGR
of 25.6%.
And if we look at the companies that did not make the
grade of a Hyper Value Creator, the 10 year gross CAGR
of this group of stocks was 17%, which is still great.
It makes a lot of sense to focus on the Hyper Value
Creators. Invest in the best, forget about the rest.
American Association of
Individual Investors
On March 10, the American Association of Individual
Investors (AAII) covered the stock-picking strategy of
Warren Buffett and gave us a list of 30 stocks that
passed their screen based on Robert Hagstrom’s
extensive writings about Buffett’s approach. You can find
the article HERE.
Here is the list of Hyper Value Creators found in the 30
stock list of the Buffett Hagstrom screener:
Company Market Cap P/S
Fortinet Inc 30263 11,7
Medifast Inc 2918 3,1
Chemed Corporation 7100 3,4
The Ensign Group, Inc. 4907 2,0
Accenture Plc 166575 3,8
ABIOMED, Inc. 13576 16,1
Qualys Inc 3977 11,0
National Beverage Corp. 5204 5,2
Logitech International SA (USA) 16225 5,5
Humana Inc 53604 0,7
WNS (Holdings) Limited (ADR) 3899 4,2
Facebook Inc 765031 8,9
Arista Networks Inc 21623 9,3
11 March 2021
The 10 year average Total Shareholder Return, TSR (%),
of the Hyper Value Creators is 760%.
Some might think that “the algorithm” is “just” another
type of Buffett Munger screener. Yes and no. Of course I
use the well proven Buffett metrics like return on
invested capital (ROC/ROIC) , but there is much more to
it. I believe that “the algorithm” better balances risk,
growth and profitability than any other “screener” that I
know of and also has a better approach towards ranking
the stocks. But I am perfectly ready to be proven wrong.
Copyright © 2021 by The Value Firm®. All rights reserved.
Alta Fox Capital Management
Connor Haley founded Alta Fox Capital Management, LLC
in April 2018. It’s a long/short hedge fund based in Fort
Worth, Texas. They scour the world for the highest
quality businesses at the lowest possible prices
regardless of size. This often leads to unusual corners of
the market that the majority of institutional investors
cannot or do not consider.
Their prototypical investment is a high-quality business
that has not yet attracted significant institutional
coverage, is not included in major stock indices, and has
a multi-year profitable growth runway with high returns
on capital. It is their belief that these undiscovered
gems can produce attractive and often uncorrelated
results relative to the broader market.
The Alta Fox 2020 Summer Intern Class Project,
consisting of Owen Stimpson, Max Schieferdecker and
Elizabeth DeSouza, analyzed the highest performing
stocks over the last five years and identified their
common characteristics, trends, and catalysts to identify
strategies to find the next set of high performing stocks.
These interns did a fantastic job. It’s definitely worth
reading. You can find it on the Alta Fox website.
They researched the business of each company
individually using a standardized 6-page slide deck
format and compiled quantitative and qualitative data
from all companies, analyzed it, and then drew
conclusions based on it. Here are the 5 high-level
takeaways and a framework to screen for future multi-
baggers:
1. Look for businesses with advantageous positioning:
80% of businesses had moderate-to-high barriers to
entry and 91% had moderate-to-high competitive
advantages.
2. Spend time on financially healthy companies: 88% of
outperformers came from a position of financial
health in June 2015 and grew faster than the market
might have anticipated. Looking for financially
healthy companies, rather than turnarounds, is also
less risky.
3. Acquisitions can create value: While many
acquisitions fail to create value, the highest
performing stocks often leverage acquisitions to
bolster their returns. If you are looking for
phenomenal returns, finding companies that make
strong acquisitions will increase your odds of
success.
4. Don’t rely on multiples: While it is always better to
buy a great business at a low multiple rather than a
high one, many of the top performing stocks began
with already healthy multiples – those multiples
often expanded even further.
5. Be open to international companies.
The third one is an eye opener to me:
The highest performing stocks often
leverage acquisitions to bolster their returns.
Thank you, Elisabeth, Max and Owen. Let me return the
favor. What I would like to add to this list is: look for an
operator-owner with skin in the game and/or a family-
controlled business. Here is a chart that illustrates how
founder led companies outperform:
I mentioned before that “the algorithm” has this ability
to identify Hyper Value Creators early in their
competitive life cycle. The algorithm was designed with
something that’s known as “reinforcement learning” in
mind. Reinforcement learning, also known as “learning
by trial and error” is one of the basic building blocks of
the Artificial Intelligence programs used by DeepMind, to
develop software that’s able to play Atari Games very
well.
I studied stocks that did very well over the last 10 years,
like Amazon, Monster Beverage and Mercadolibre,
looking for commonalities is terms of balance sheet
strength, return on invested capital (ROIC) and growth. I
put these insights into code and ran “the algorithm” on
the financial data from 2005 to 2009 for all NYSE or
Copyright © 2021 by The Value Firm®. All rights reserved.
NASDAQ listed companies by then. The result was not
very compelling.
Then I studied these mediocre results, identified
improvements, put it into code and ran “the algorithm”.
Again not very compelling. So I studied the results,
etcetera, etcetera. And that’s what you repeat time after
time, until you come up with something that actually
works in terms of generating a list of 25 stocks with a
high degree of multi-baggers in it, based upon the 2005
to 2009 financial data.
What you look for is something that worked very well in
the past and what you hope for is that it will work very
well from now on and way into the future. The Value
Creation Engine (VCE), a for growth adjusted return on
capital (ROIC) measure, is based upon the results of this
reinforcement learning approach that I applied to the
historical financial data of superior multi-baggers. Is this
a winning formula? I just don’t know. But given its back
test results, which you can find in the Winter 2021
Edition on Intelligent Cloning, it would be a fantastic act
of omission not to give it a go.
I ran the algorithm on the 104 Alta Fox multi-baggers to
find out if “the algorithm” was able to identify these
companies as a Hyper Value Creator. Please find the
results in the attachment.
For instance, Zynex, the first company on the list, was
identified by the algorithm as a Hyper Value Creator in
2018, based upon the financial data from 2013 to 2017.
The algorithm was able to identify 25% of these multi-
baggers in 2015. And since you only have to find a few
ideas a year, I am more than happy with the result.
As you know, most of the todays great companies once
started as a small one. And there comes a time when
such a company, early in its competitive life cycle,
catches up steam and steps on the path of “robust
profitable growth”, or “profitable compounding” if you
will. The algorithm surely helps to identify that moment
in time.
So here we are
If I had to set up a new fund today, it would have almost
the same characteristics as the Brown Capital
Management International Small Company (BCSVX).
That’s actually the fund where I “cloned” my latest
investment in XPEL from.
Finding tomorrow’s star growth stocks today is not easy.
What to look for are “exceptional growth companies”,
with four qualities: solid revenue growth, a competitive,
sustainable position in its industry, executives with a
vision of the future and an ability to make it happen, and
profitability to fuel and sustain earnings growth. That’s
how Brown Capital defines it and I agree.
Many of the BCSVX holdings tilt toward e-commerce,
electronic payments, smart logistics, cloud adoption and
innovative health care solutions. German health care
firms Evotec and Stratec and Canadian logistics company
Kinaxis are amongst the fund’s top holdings.
The new fund I am thinking of would look for these type
of Hyper Value Creators (HVCs) early in their competitive
life cycle, when they are still small. The fund would be a
stocks only fund. No leverage, no derivatives, no shorts,
no bull shit.
Actually, I am looking for one or more entrepreneur(s) or
strategic partner(s) with the courage to give it a go and
who provide a critical mass of capital in exchange for
economic participation in the fund. I am open to discuss
a seed model based upon revenue sharing.
There is an Investor Presentation available. Let’s set up a
ZOOM meeting to discuss it in a 10 minute presentation.
Just send me an email: [email protected]. For
professional investors only.
Stay safe!
All of those risk models…
They are great, until complete chaos happens.
Peter
Peter Coenen
Founder & CEO
The Value Firm®
28 March 2021
Copyright © 2021 by The Value Firm®. All rights reserved.
This presentation and the information contained herein are for
educational and informational purposes only and do not
constitute, and should not be construed as, an offer to sell, or a
solicitation of an offer to buy, any securities or related financial
instruments. Responses to any inquiry that may involve the
rendering of personalized investment advice or effecting or
attempting to effect transactions in securities will not be made
absent compliance with applicable laws or regulations
(including broker dealer, investment adviser or applicable agent
or representative registration requirements), or applicable
exemptions or exclusions therefrom. The Value Firm® makes no
representation, and it should not be assumed, that past
investment performance is an indication of future results.
Moreover, wherever there is the potential for profit there is also
the possibility of loss.
Everybody makes mistakes now and then. If you find any, let me
know: [email protected]. Always do your own research!
Copyright © 2021 by The Value Firm®. All rights reserved.
Attachment
Company 2015 2016 2017 2018 2019 2020
Zynex x x x
Endor x x x x x
Xebec x x
Appen x
Fortnox x x x x x x
KORU/ReproMed ChemoMetec x x x x
Games Workshop x x x x x x
Genovis Xilam x x x x x x
Five9 Jumbo x x x
Hypoport x x x x
Boohoo Group x x x x
Phoslock Technologies Clover x
VOW ASA Bactiguard Pro Medicus x x x x
Intelligent Systems Semler Scientific x x x x x
Keyword Studios x x x x x
Hub24 Ltd Secunet x x x x x
Future Plc x x
Casella Simulation Plus x x x x x
Frontier Developments x x x
Altium Ltd x x x x x
Biotage x x x x
Alliance Data3 x x x x x x
Skyline Champion x x x x
Mensch und Maschine Software SE x x x x
Service Stream x x
AB Dynamics x x Soitec x x x x
YouGov x x x
Novanta Chegg x Bouvet x x x x x x
GlobalData x
Eckert & Ziegler Fever-Tree x x x x x
Quidel x
Exelixis x x x x x
BioLife Mercury Systems VitroLife x x x x x x
Evi Industries x x x x EOS x x x x
Copyright © 2021 by The Value Firm®. All rights reserved.
Company 2015 2016 2017 2018 2019 2020
BioVentix x x x x x x
Tristel x x MedCap x
Enlabs Solutions 30 LUNA Medistim ASA AMBU B Learning Technologies Group x x x x x
Note x Dicker Data x x x
Aphria CargoJet Kitron x XPEL x x x x x x
JD Sports Fashion x x x x Invisio x x x x x
Kinaksis x x
RWS Group Eldorado Resorts FOX Factory x x
Beijer Ref x
Bachem ETSY x x x
Biotelemetry x x x
Hexatronic x x Arrowhead Medios AG Amedisys x x x
Design Group Ideagen x x
Sectra x x x x
Tomra ATOSS Software x x x x x x
Esker x x x x x
Bechtle LGI Homes x x x x
Globalscape Datagroup x City Chic Collective x
Gamma x x x x x
National Research Corporation x x x x x x
Troax x Neogenomics S&T AG x x Salmar x x x x x x
Vitec IVU Traffic Technologies x x
Inphi x x x Entegris x x Norway Royal Salmon x x x
Also x